Equities

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Screen Shot 2018-11-15 at 1.43.12 AMSectors & stocks on the move Defensives still lead tactically & we flag five sector relative movers


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Takeaway: UNFI, SGRY, TSLA, DE, DRI, FL, MCHP, KSS

Investing Ideas Newsletter - 11.08.2018 heading south cartoon

Below are analyst updates on our eight current high-conviction long and short ideas. We will send a separate email with Hedgeye CEO Keith McCullough’s refreshed levels for each ticker.

IDEAS UPDATES

UNFI

Click here to read our analyst’s original report.

No update to our short thesis on United Natural Foods (UNFI) this week.

We continue to think investors shouldn’t be blinded by strong top-line growth driven by Whole Foods representing roughly 37%, because there is immense risk embedded within the margin lines. The company is under pressure to manage operating expenses while gross margins deteriorate, we expect their ability to do so going forward will be challenged by labor costs and capacity constraints (additional capacity not coming until the Fall).

Strong sales performance continues to be dampened by rising cost pressures that we contend will not abate anytime soon, leading to further deterioration of the operating model. Given our bearishness on the independent segment and some other issues UNFI may face going forward, we are not buyers of this new CapEx cycle.

This current and continuing price competitive environment is tough for smaller players (independents represent ~25% of sales) to compete in given their lack of scale versus the larger retailers.

Also, as we’ve highlighted in recent weeks, we view the SVU acquisition as very troubling, that could cause problems for the company going forward.

SGRY

Click here to read our analyst’s original report.

On Friday, Healthcare analyst Andrew Friedman discussed the short thesis on Surgery Partners (SGRY) on The Macro Show. Click here or the image below to watch.

Investing Ideas Newsletter - Healthcare SGRY AF 11.9.2018play

TSLA

Click here to read our analyst’s original stock report.

We continue to see evidence that Tesla‘s (TSLA) brand is weakening given the controversy in the name. Test drive utilization is falling again in our data, and previously impervious Model X used prices have been dropping.  A key risk remains the potential for an extension of the EV tax credit, potentially undermining our ‘first loser disadvantage’ downside catalyst.

Below are some key charts based on our research…

Investing Ideas Newsletter - tsla1

Investing Ideas Newsletter - tsla2

Investing Ideas Newsletter - tsla3

DE

Click here to read our analyst’s original stock report.

“One of our favorite shorts in our  INVESTING IDEAS product (weekend research from my analyst team) remains Deere (DE),” writes CEO Keith McCullough earlier this week.

Why?

In addition to our fundamental short thesis on Deere, we have been bearish on the Industrials sector for much of 2018. Are we heading towards another recession in that sector like the one that hit in 2015 and 2016?

Hedgeye Industrials analyst Jay Van Sciver sees rough going for Industrials, at least over the next 3 to 6 months, partly caused by difficult comps up against the spending spree the sector went on ahead of tax reform.

“There was this expectation in the sector that everybody was going to go out and buy a backhoe for Christmas and expense it and bring their taxes down,” Van Sciver explained in a recent edition of The Macro Show from this week. “That’s not really the way it played out. And now you’re facing much harder comps.”

Overall however, the drop-off does not look like it will be as steep as the one a few years ago – for now.

“We remain data dependent,” Van Sciver says. “Could we see a real blow-up in a more specific sector like the ag space? Sure. But we haven’t seen it yet, and we don’t see a ton of really dramatic downside like in 2016.”

Click here to watch this entire edition of The Macro Show hosted by Van Sciver.

DRI

Click here to read our analyst’s original stock report.

The acquisition of Cheddar’s is a problem for Darden Restaurants (DRI)! This is an example of the issues the company faces as the CEO said on the most recent conference call “Dave George, our Chief Operating Officer, will continue to dedicate a significant amount of his time working side-by-side with the Cheddar’s team to improve the performance of the business.”  Is it a great use of the COO’s time to spend that much time on a small part of the business?

Meanwhile, in the most recent quarter…

  • Food and beverage costs were favorable 40 basis points as pricing of 1.9% and continued cost savings initiatives more than offset continued investments in food quality.
  • Restaurant labor was unfavorable 70 basis points despite continued productivity gains and sales leverage. The increase was driven by hourly wage inflation of approximately 5%, previously announced workforce investments and headwinds related to mark-to-market expenses for General Manager and Managing Partner equity awards.
  • Restaurant expense was favorable 30 basis points as sales leverage more than offset inflation and marketing expense was favorable by 20 basis points.
  • Restaurant level EBITDA margin of 18.2% was up 20bps YoY.

FL

Click here to read our analyst’s original stock report.

Adidas reported earnings on Wednesday and there are several bearish data points to highlight in relation to Foot Locker (FL).

First, and most notably, is the prioritization of digital sales being conducted through Adidas’ owned channels.

“Two years ago, we would do updates maybe monthly or quarterly. Now we do updates, software updates to the site on a weekly – on a daily basis to continue to look upon increasing site speed, making checkout easier.”
– Kasper Rorsted.

This initiative, being deployed by NKE and ADS is central to our Retail team’s long term bear thesis on FL, that over time FL suppliers will continue to move more direct and away from the traditional retail channels (i.e. Foot Locker). Adidas ecommerce was up 76% this quarter! That’s a lot of incremental sales that are being kept by the brand and not shared with retail.

Adidas also discussed on the call the strength in its wholesale partnerships with Kohl’s and Dick’s Sporting Goods as they continue rolling out a greater product assortment with these partners. This was not overly optimistic commentary for FL in terms of where they stand on the list of partners for Adidas given Foot Locker was not even mentioned on the call.

FL reports 3Q earnings on November 20th, we will update you with more information into the print.

MCHP

Click here to read our analyst’s original stock report.

Below are some takeaways from Microchip Technology‘s (MCHP) earnings report:

  • Confusing short-term signals as orders re-accelerated in October after the September quarter cleanout of inventory, although some of the October strength might be excess shipment ahead of the feared increase in tariffs from 10% to 25%.
  • On the long-term side, no one asked about the lawsuit or the risk that Steve might have to recuse himself from the CEO role. The company is fixing MSCC operationally but the ongoing evidence of excess inventory (over 8 months for high-reliability products) only buttresses our view that real growth for MSCC was even worse organically than the feeble numbers we had scrubbed to. In other words, the point of buying MSCC…is to hurry up and buy another semi company. Steve even noted that his strategy is to buy underperforming semiconductor assets, which is a fine strategy, but does not come with a premium or high performance analog multiple.
  • If there is a risk to our Short thesis it probably comes from the s-t signals with maybe a very brief trade into year-end before it collapses in February.

KSS

Click here to read our analyst’s original stock report.

An often overlooked risk for Kohl’s (KSS) is its exposure to its credit card portfolio.

Kohl’s has its private label credit card partnered with Capital One. Sales through this card account for 60% of the total company’s sales.  And the EBIT from the shared revenue and costs of the card partnership equates to about 35% of EBIT or $2.30 in earnings.

The unappreciated risk is that investors don’t realize how much sales and earnings are reliant on the health of the credit cycle.  When the credit cycle rolls over (often around the time of a recession) the credit EBIT can easily go down 25-50% or more, meaning EBIT goes down about 10-20% just from the portfolio impact.

Then you have to think about what the impact will be when cardholders accounting for 60% of sales start to default, meaning they have no money to shop.

Since KSS switched its partnership to Capital One from JP Morgan in 2011, the credit quality of cardholders has fallen, so we think there is a material amount of subprime customers that are driving comps today.  That means significant comp pressure when the economy weakens.

So in the next credit down turn we think there is a high probability that we could ultimately see KSS EBIT down 25-50% or more, and with the stock at $80 the market is saying that risk doesn’t exist.

Investing Ideas Newsletter - kss

 

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US Equity Strategy in Pictures

Screen Shot 2018-11-08 at 12.09.57 AMEarnings Season Update Week 4

 

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Investing Ideas Newsletter

11/03/18 07:02AM EDT

Investing Ideas Newsletter - 10.30.2018 Jaws bull

Below are analyst updates on our eight current high-conviction long and short ideas. We will send a separate email with Hedgeye CEO Keith McCullough’s refreshed levels for each ticker.

IDEAS UPDATES

UNFI

Click here to read our analyst’s original report.

United Natural Foods (UNFI) We don’t think investors should be blinded by strong top-line growth driven by Whole Foods representing roughly 37%, because there is immense risk embedded within the margin lines. The company is under pressure to manage operating expenses while gross margins deteriorate, we expect their ability to do so going forward will be challenged by labor costs and capacity constraints (additional capacity not coming until the Fall).

Strong sales performance continues to be dampened by rising cost pressures that we contend will not abate anytime soon, leading to further deterioration of the operating model. Given our bearishness on the independent segment and some other issues UNFI may face going forward, we are not buyers of this new CapEx cycle.

This current and continuing price competitive environment is tough for smaller players (independents represent ~25% of sales) to compete in given their lack of scale versus the larger retailers.

Also, as we’ve highlighted in recent weeks, we view the SVU acquisition as very troubling, that could cause problems for the company going forward.

SGRY

Click here to read our analyst’s original report.

We are more bearish on Surgery Partners (SGRY) after the preliminary 3Q18 release and news of incremental capital raise (which was successful). This stock is high-beta, high-leverage, with no cash flow and makes for a great Quad 4 (i.e. U.S. Growth and Inflation slowing) short, and the stock remains significantly overvalued.

Investing Ideas Newsletter - sgry

TSLA

Click here to read our analyst’s original stock report.

We continue to see evidence that Tesla‘s (TSLA) brand is weakening given the controversy in the name.  Test drive utilization is falling again in our data, and previously impervious Model X used prices have been dropping.  A key risk remains the potential for an extension of the EV tax credit, potentially undermining our ‘first loser disadvantage’ downside catalyst.

In a risk to a leg of our short thesis, on the potential for an EV tax credit extension Joe McMonigle, our Energy Policy head notes that the odds of an EV tax credit extension are above current expectations: “Divided government may usher in some horse-trading on big spending bills….As in years past, we expect clean energy to be the big beneficiary here.  On tax policy in particular, we think there is the potential for solar and wind tax cut extensions and other tax policy tweaks that have affected the credits.  In addition, we think there is the potential for an extension of the Electric Vehicle Tax Credit or reforms like removing the 200,000 vehicle caps on individual manufacturers.”

Investing Ideas Newsletter - tsla

DE

Click here to read our analyst’s original stock report.

Deere (DE) is facing a challenging market with rising input costs, lower US crop prices, and elevated expectations.  Wholesale sales have tracked ahead of retail, and pricing has been flat in recent quarters. Below are some additional highlights regarding our DE short call.

  • Cost Increases Meet Weak Pricing: In recent quarters, equipment sales price realization has been flat. Heading into 2019, DE will likely need to reverse pricing trends.
  • Inventory To Sales Elevated: While total inventories are down from peak, relative to current sales inventories remain elevated.
  • Wholesale v Retail: While wholesale sales have rebounded, retail hasn’t kept pace.
  • Finance Sub Accommodation:  We see evidence that Deere Financial has offered accommodating lease terms and payment terms, supporting volumes during the industry downswing with costs potentially recognized on a lag.

Higher Costs, Lower Volume:  We expect shares of DE to reprice downward as the company is pinched between sales volume pressure and higher input costs amid weak pricing.  We expect >25% downside in share of DE into FY19.

Investing Ideas Newsletter - DE

DRI

Click here to read our analyst’s original stock report.

Darden Restaurants (DRI) is on the Best Idea SHORT list, as we believe that sales trends will slow meaningfully over the next six months putting pressure on the stock price!

In the most recent quarter, DRI put up great results. Olive Garden put up one of its best quarters in recent memory, just the second quarter with a comp over 5% since FY12, and well above the five-year average comp of 1.4%!  Olive Garden’s SSS was 5.3%, strongly beating consensus estimates of 2.7%, representing a 20bps sequential increase in the two-year average. Olive Garden is leading the industry in traffic with growth in 1Q19 of 1.5%, with pricing slightly below industry average at 1.9%. Importantly, 30% of the growth was driven by off-premise.

Can it get any better than this?  To put this performance in context, the 10-year average NTM EV/EBITDA multiple is 8.5x and back in 2008 the stock was trading closer to 7x.  With the stock trading at nearly 2 standard deviations over its 10-year average, the good news is priced in.

FL

Click here to read our analyst’s original stock report.

Foot Locker (FL) is up 3.7% WoW taking part in the broader market strength realized this past week. A few notable data points came out in earnings over that time frame.

First, Under Armour (UAA) reported their 3Q18 earnings on Tuesday. Management talked up the strong sell through of select styles like HOVR, Project Rock and the Curry 5. Yet we’d point out that the Footwear segment for UAA remained flat YoY and slowed significantly from the 14% growth in 2Q18. BGFV, a lesser known retailer and FL competitor in the west also reported earnings this week. The BGFV management cited footwear sales coming in below expectations, comping down MSD with particular weakness being realized in athletic footwear styles.

These points in isolation are not enough to support our short thesis. However, in the context of our broader short call, it gives us some sense that footwear sales have slowed/underperformed relative to last quarter at least in current sales trends from an FL supplier and competitor.

MCHP

Click here to read the Microchip Technology (MCHP) stock report Technology analyst Ami Joseph sent Investing Ideas subscribers this week.

KSS

Click here to read our analyst’s original stock report.

Kohl’s (KSS) CEO Michelle Gass was out doing WSJ and CNBC interviews on the last few days of the quarter.

That is likely a positive read on near term sales and is driving some of the near term strength in the stock.  Earlier in the quarter, KSS “reminded” investors in meetings that it is a very weather sensitive company.

The weather dynamic has inflected in recent weeks, so perhaps comps have as well and now the CEO is comfortable being in the public prior to a print.

In the context of our short case though, there was an important takeaway from the interviews and that’s the read on the Amazon partnership, which is a notable part of the current bull case.

When asked about Amazon Gass said: “Based on the volume of returns we are getting, people are using the service. What we are trying to determine is, of the people coming in and returning something from Amazon, how many are crossing the aisle and buying something from Kohl’s?”

This partnership started a year ago (last Oct), it has only been scaled from 80 to 100 stores… the added 20 stores are in the Wisconsin area (near HQ) which to us says (along with Gass’s comments) that the company is still trying to assess whether this actually drives traffic and is worth the cost.

Traffic did not grow for KSS in the last 2 quarters, and we’d argue managements actions demonstrate this Amazon partnership is not driving traffic/comp as much as bulls expect

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Earnings Season Update Week 2- so far, so good – but Week 3 is key